Chapter 5 Money Markets

I. Global Money Markets

a. Money Market Participants
i. Issuers of money market instruments
1. Government entities
2. Securities dealers
3. Commercial banks
4. Other corporations (including non-profits) that need to raise funds
ii. Broker-dealer
1. Trades securities for its own account or on behalf of its customers
a. Acts as Broker when trades orders on BEHALF of customers
b. Acts as Dealer when trading for own account
2. Holding securities
a. Can hold them in their own name, customers name, or street name
i. Street name securities are held in the brokers name on
behalf of the brokers customer
ii. Doesnt affect rights of the actual owner
iii. Eliminates the need to re-register/re-issue securities in the
name of the actual owner
iv. Done to simplify trading registration takes several days in a
manual environment and securities trade daily
3. Compensation
a. Charge fees/commissions for their services
4. Role in money markets
a. Places the majority of new issues in the primary market
b. Provides the secondary market with the necessary liquidity for
outstanding issues
5. Dealer Role
a. Act as counter party in transaction
b. Enter into REPO agreements
i. Used to finance a dealers securities inventories
iii. Central Securities Depositories CSDs
1. Companies that hold securities:
a. That are certificated or non-certificated or dematerialized
b. Enables book-entry transfer of securities
2. Facilitate money market transactions in other ways too
a. Trade matching
b. Clearing and settlement
3. Examples
a. Depository and Trust Company DTC
b. Euroclear in Belgium
c. Singapore Exchange SGX
4. Nearly all SHORT-TERM securities are issued in NON-CERTIFICATED or book-
entry form
iv. International Central Securities Depositories ICSDs
1. Are CSDs that settle trades in international securities in addition to domestic
a. Ex: Clearstream, Euroclear, and SIX securities Services
b. Investment Risk Considerations
i. Introduction
1. Money markets have a primary need to minimize risk to principal while
maintaining liquidity
2. Accompanied by lower returns on yields and low-risk levels
3. Appropriate for conservative, short-term portfolios
ii. Credit/Default Risk
1. The risk that payments to investors on a security will not be made under the
original terms
2. Higher risk = higher yields
3. Credit ratings are assigned based on the issues default risk and seniority
a. Additional consideration given to collateral, backup lines of credit, bond
issuance, or any credit enhancement
b. If a bank provides a letter of credit L/C, the obligation assumes the
credit rating of the bank
4. Impact of unrated short-term investments
a. Must be evaluated for credit risk an involved process
b. If it must be resold new owner would most likely need to perform a
credit risk evaluation
c. This process makes it more difficult to find a buyer or it could delay the
sale at minimum
d. Holding these investments in an organizations short-term portfolio
would require FOOTNOTES about the securities in any audited financial
statements
iii. Liquidity Risk
1. Risk that a security cannot be sold quickly without experiencing an unacceptable
loss can also affect YIELD and PRICE on a security
2. Primary determinants of a securitys liquidity
a. Marketability
b. Maturity
3. Even with active secondary markets holding investments over longer period of
time increases the exposure to price/interest rate risk
iv. Price/Interest Rate Risk
1. Risk arising when interest rates change for securities that are identical/similar to
portfolio securities
2. Longer maturity = greater price risk
a. Since market values are more responsive to changes in market interest
rates
3. Reason for existence
a. A fixed-rate security may have to be sold prior to maturity in a market
where interest rates are rising causing a loss of principal on the salw
4. Re-investment risk
a. Occurs when the proceeds from an investment that - has been sold, has
matured, or has been redeemed prior to maturity must be reinvested
after market interest rates have declined
5. Interest rate risk management through use of swaps
v. Foreign Exchange (FX) risk
1. Arises when securities denominated in foreign currencies are held in an
investment portfolio
a. Risk of change in the rate of exchange
2. Present whether the investment is sold prior to maturity or redeemed at maturity
3. How to limit
a. Only permit investments in foreign securities in 2 scenarios
i. When the investment is issued in an economically and
politically stable country
ii. When the security is suitable as part of an overall currency
hedging strategy
c. Types of Money Market Instruments and Investments
i. Commercial Paper CP
1. Allow companies to raise funds in the short-term money market
2. Refers to tradable promissory notes issued by companies as opposed to banks
3. Normally an unsecured obligation
4. Maturity range
a. Overnight 270 days for publically traded CP
b. Overnight 397 days for private placement CP
c. Most CP matures in less than 45 days
5. Returns
a. Doesnt pay interest is sold at discount and holder receives face value
at maturity
6. Advantages
a. Investment-grade CP highly liquid
b. Broad range of maturities precise investment
7. Disadvantages
a. Not secured against any particular asset
b. Though it may be issued with a backup line of credit or standby letter of
credit that will pay off the CP in the event of default
ii. Asset-Backed Commercial Paper ABCP
1. Most features of above CP and is secured against specific assets
a. Usually secured against short-term traded receivables
2. Issued through a sponsoring financial institution known as conduit
3. Single-seller backed by assets from a single institution
4. Multi-seller backed by assets from multiple institutions
5. Advantage
a. Primary offers more security than CP
b. Credit enhancement from sponsoring bank ensures timely repayment at
maturity
6. Disadvantage
a. Complex structure makes it harder to appraise the overall risk may
require 3
rd
party monitoring
b. Complex structure + smaller ABCP market = higher liquidity risk
i. Investors receive higher rate of return for higher risk
iii. Bank Obligations
1. Banks raise funds with the following
a. Time deposits
i. Savings accounts
ii. CDs & Negotiable CDs
b. REPOs
c. Bankers Acceptances
2. Eurodollar deposits
a. May be issued as negotiable Eurodollar CDs or non-negotiable
Eurodollar time deposits both are interest bearing
b. Non-US and foreign branches of US banks raise funds in global money
markets through EURODOLLAR deposits
c. Many multinational businesses invest in these issues because they
provide the ability to invest in USD-based securities that historically
have had a higher rate of interest than comparable US bank securities
i. Due to fewer regulations and lack of US reserve requirements
3. Yankee CDs
a. USD-denominated CDs sold by US branches of non-US banks
b. Typically sold through the NY branches of foreign banks carry
minimum investment of $100,000
c. Historically has a higher rate of interest than comparable US bank
securities
i. Regulatory differences and lack of R.R
4. Banker Acceptance BA
a. Arises out of commercial trade
b. Represents a time draft that is issued by a purchaser of goods to pay a
supplier & that has been accepted by the bank on which the draft is
drawn
c. Holder can wait until maturity to receive payment in full or sell it at
discount to receive money immediately
iv. Government Paper
1. State & local government agencies/entities raise money in the short-term money
market by issuing a range of short term paper
a. Treasury bills or government-issued promissory notes
2. Market
a. Liquid and highly active
3. Issuance
a. Issued on a discount basis
b. Variety of maturities
c. Low returns because of the generally low default risk sovereign risk
4. Examples
a. UK gilts, US Treasuries, German Bunds, Japanese Government Bonds
JGBs, and Brazilian government bonds
5. T-Bills
a. Issued with original maturity at less than a year on a discount basis
i. Maturities of 4, 13, 26, or 52 weeks
b. Newly issued Treasury Offerings are sold through a multiple-price,
sealed-bid auction
c. Competitive T-Bill purchase
i. Bids are accepted starting with the highest price lowest yield
offered, down to the lowest price necessary to sell the entire
issue
d. Non-Competitive T-Bill purchase
i. Bidder guaranteed to receive the desired amount of bills at the
average price from the competitive-bid process
e. Eligible bank, broker-dealers, and other private & government entities
tender bids for specific amounts of the offered securities
v. Floating-Rate Notes FRNs
1. Companies and banks issue FRNs to raise funds in the short-term market
2. Maturities typically one year or longer
3. Pay a regular coupon as well as PROMISE or a return of their face-value at
maturity
a. Actual return = coupon interest rate + capital gain/loss from FRN
transaction since theyre traded on secondary markets at discount
4. Interest rate resets periodically based on LIBOR or the Euro interbank offered
rate Euribor
a. As a result FRNs are sold at a QUOTED SPREAD over the stated
reference rate
b. The spread remains constant while the reference rate can vary
5. Perpetual FRNs
a. Issued with no maturity date investor can only recapture their capital
by selling them on the secondary market
6. Advantages
a. Variable rates make them appealing in an uncertain interest rate
environment and when investors dont want to lock into a fixed rate
b. Offer relatively attractive yields
c. Regular resetting of the coupon = less capital volatility than fixed-
interest rate securities
d. Issued with credit enhancements to improve marketability
i. May be secured by collateral pledged by borrowers
e. Has a published credit rating
7. Disadvantages
a. Capital value can fluctuate in the time between interest rate resets that
bring the securitys yield in line with the rest of the market
b. Bid-offer spread of an FRN tends to be wider = regular trading can
erode any yield advantage relatively quickly
c. Like CDs, tend to be issued with large denominations
vi. Repurchase Agreements (REPOS)
1. Typical REPO
a. Bank/securities dealer sells government securities it owns to an investor
then agrees to repurchase them at a later date at slightly higher price
b. From the investors perspective that buys the securities with the
promise to sell them back = reverse repo
2. Classification: overnight, term (2+ days), and open (no maturity)
3. Advantages
a. Ample opportunity to tailor its maturity and interest to each partys
requirements
b. Taking legal possession of the underlying security also gives the
investor a high degree of comfort since REPOS can be sol if the selling
counterparty defaults on the agreement settlement risk
4. Disadvantage
a. Can be set up with standard contracts but the investor needs to
perform analysis/due diligence to determine a fair price among other
things and creditworthiness of the exchanged security
vii. Other Types of Money Market Investments
1. Money Market Funds MMFs
a. Pools of money market instruments in which investors have an
ownership interest
b. Generally have an Net Asset Value NAV of one unit of currency of the
offering such as dollars, euros, sterling, etc.
i. As long as NAV does not break the buck or fall below $1, the
investors initial investment is SECURE
c. Regarded as a cash equivalent
d. Configuration
i. Report a NAV of $1/share
ii. May not hold securities whose maturity exceeds 397 days
iii. Must maintain a dollar-weighted average portfolio maturity of
60 days
e. Regulations
i. Regulated by the SEC
ii. Restricts investments in MMFs by quality, maturity, and
diversity
iii. 2010 imposes liquidity requirements
f. Advantages
i. Provides an organization with a professionally managed,
marketable securities portfolio at a low cost
ii. Charge management fees/service costs based on investors
balance, level of activity, and services provided
iii. Administratively easy frees up treasury resources for other
tasks
iv. Offer daily liquidity
v. Pays dividends (usually monthly) based on funds average yield
for the dividend
vi. In changing interest rate conditions ex. Falling - MMF
managers may extend the maturities of new securities
purchases in the funds underlying portfolio to LOCK in yields
1. = greater return of longer-term instruments
g. Economies of scale of large MMFs
i. Obtain very competitive trading terms
ii. Helps to ensure yields are not eroded by active management
of the underlying portfolio
iii. Most MMFs offer same-day settlement just as liquid as
overnight deposits
iv. Credit rated by all leading agencies risk profiles easy to
appraise
2. Short-Duration Mutual Funds
a. Invest in securities with maturites EXCEEDING maturities in most
money market instruments
b. In most cases longer-maturity funds offer not only higher average
returns, but also a higher risk of fluctuations in their underlying value
c. Average maturity 1 to 3 years
d. Place most holdings in specific types of instruments ex. Govt issues
3. Investment Sweep Accounts
a. Accounts that contain any excess end-of-the-day funds from a
depository institution
b. Offer investments in REPOS, other MMIs, managed accounts, and
mutual funds
c. Lower returns minimal risk and minimal time and effort

II. Short-Term Money Markets in the U.S (III.)
a. Processing an Clearing of Short-Term Investments in the U.S
i. Commercial Book-Entry System CBES
1. A multi-tiered, automated system for purchasing, holding, and transferring
marketable Treasury securities
2. Exists as a delivery system provides simultaneous transfer of securities against
settlement of funds
3. Top Tier
a. At the top is the NBES National Book-Entry System operated by FED
b. Operated in its capacity as the fiscal agent of the US Treasury
4. Middle Tier
a. Depository Institutions hold book-entry accounts for their customers:
brokers, dealers, institutional investors, and trusts
5. Lower Tier
a. Each broker, dealer, and financial institution maintains book-entry
accounts for individual customers, corporations, entities, etc.
6. Indirect Holding holding of securities on the book-entry system of the firm
that purchases securities on behalf of investors
7. Succeeded in replacing paper securities with e-records prevents theft, loss, and
counterfeiting
ii. Depository Trust & Clearing Corporation DTCC
1. Works through its subsidiaries to provide clearing, settlement, and info services
2. Formed in 1999 though combo of DTC depository Trust Company, and NSCC
National Securities Clearing Corporation
3. Acts as a legal depository (holding place) for most stock & bond certificates
a. Brings significant efficiency to market clearing process
4. As an industry-owned corporation operates at an at-cost basis
5. At cost basis charges transaction fees and returns excess revenues to its
members
b. US Money Market Participants
i. US issuers
1. US Treasury
2. Federal Agencies & GSEs
3. Securities Dealers
4. Commercial banks & Municipalities
5. Other corporations that raise funds borrowing in Money Market
ii. Fed
1. Responsible for managing the initial sale and subsequent settlement of most
book-entry Treasury security sales/purchases
2. Implements US monetary policy through FOMC
3. FOMC implements its monetary policy through purchase/sale of Treasury
securities in secondary markets often with REPOS
4. Fed buys, sells, and redeems treasury securities in its role as fiscal agent
c. US Federal Agency and Government-Sponsored Enterprise GSE Securities
i. Carries either an explicit or implicit guarantee by the US government
ii. Created as one of 2 types:
1. Asset-backed debt
a. Often require greater due diligence to fully investigate security issue
and all assets used as part of collateral
b. Often require Sophisticated analytical skills
2. Direct debt
iii. GNMA Ginnie Mae Government National Mortgage Association
1. Provides liquidity for gov-sponsored mortgage programs though its MBSs plan
2. MBS plan indiv. Mortgages insured/guaranteed by certain gov-agencies are
pooled and interests in them are sold either as MBSs or REMICs real estate
mortgage investment conduits
3. Prepayment & Extension risk
a. Prepayment risk arises because as interest rates fall, mortgage
refinancing increase resulting in higher prepayment rate
b. Extension rate is opposite as interest rates rise, refinancing decrease
results in lower prepayment rate = effectively extending maturity
iv. US Department of Veterans Affairs VA
1. Also guarantees REMICs issued through its Vendee Mortgage Trust Securitization
program
2. Guarantees timely payment of principal and interest to the REMIC investor
v. GSEs
1. Private companies that act as financial intermediaries to provide funds for loans
made in housing, education, and agriculture sectors
2. Do not carry credit backing of US gov though there is strong implication that
the gov would intervene in a crisis to help pay investors because of the
importance of GSEs to public welfare
3. GSE securities are issued by Fannie Mae FNMA Federal National Mortgage
Association and Federal Farm Credit Banks Funding Corporation, Freddie Mac
FHLMC Federal Home Loan Banks Office of Finance
d. Municipal Notes, Variable-Rate Demand Obligations (VRDOs), and Tax-Exempt Commercial Paper
CP
i. Maturities of 3 months to 1 year are typical for Municipal Notes
ii. Maturities range up to 270 days for CP
iii. VRDOs are issued as long-term bonds that carry a short-term liquidity feature a put
1. Put option allows investor to sell the instrument back to issuer at par
2. Allows for liquidation either weekly or monthly
3. Supported by a credit facility, such as bank L/C
4. Often tax-exempt, but taxable instruments do exist
iv.






















Chapter 6 Capital Markets


I. Debt Market (III)
a. Medium and Long-Term Borrowing
i. Term loan
1. Fixed maturity, usually greater than 1 year
2. Can be repaid in installments or in single payment
3. Are amortizing periodic payments represent both interest and principal
4. Usually negotiated with a financial institution or other lender not bought in
secondary market
5. Typically secured by asset being financed maturity is related to assets useful
life
ii. Medium- or Intermediate-Term Notes
1. Terms in the 2 to 10 year range
2. Pay interest in periodic intervals (semi-annually)
3. Very similar to long-term bonds, but with short maturities
4. Marketable and liquid may be traded actively
iii. Long-Term Bonds
1. Introduction and Details
a. 10 30 year maturities
b. Issued like stock bought and sold in secondary markets
c. Not secured against any specific asset
d. Most are coupon bonds make regular interest payments at a fixed
rate
e. Principal is repaid in full to bondholder at maturity
f. Bond indenture contract between issuer and holder
i. Describes bond issue
ii. Lists collateral (when applicable)
iii. Makes representations and warranties
iv. Specifies covenants
v. States the terms by which company will provide funds for
redemption
vi. Sets schedule of interest payments dates and amounts
vii. Scheduled maturity and nay early redemptions/call provisions
2. Mortgage Bonds
a. Used to finance specific assets
b. Assets pledged as security against the issue
c. Substantial financial covenants/ indenture agreements
3. Unsecured Bonds Debentures
a. Represent general claims against the issuing organizations assets
and/or cash flows
b. May include sovereign, corporate, and municipal bonds
c. Companies without easily securitized assets must use debentures
4. Convertible Bonds
a. Can be converted into common/preferred stock by the holder and
sometimes even the issuer
b. Provide holder with potential for capital growth
c. Lower interest rates
5. Sovereign Bonds
a. Typically denominated in currency of issuing government
b. Transactional, political/sovereign risk with potential for FX risk if issued
in a currency other than the home currency
6. Sub-Sovereign Bonds Municipal
a. Bonds usually in the form of general obligation/revenue bonds
i. General obligation paid from the proceeds of general tax rev
ii. Revenue bonds linked directly to, and repaid from, revenues
from specific public projects or services
7. EuroBonds
a. An international bond denominated in a currency other than that of the
country in which its issued
b. Give issuers the flexibility to choose the currency and country in which
to offer their bond according to countrys regulation constraints, their
FX needs, and their preferred currency
c. Provides a multinational organization with ability to create Natural
Hedge
8. Zero-Coupon Bonds
a. Issued at substantial discount and paid face value at maturity
b. 2 advantages for corporate user:
i. No cash outflow until maturity
ii. Issuing company receives annual tax deduction until maturity
c. Disadvantages
i. Not callable or refundable
ii. Taxed on interest earnings each year even with no actual
payment until maturity
9. High-Yield Bonds
a. A.k.a junk bonds or below-investment grade bonds
b. Issued by less creditworthy entities
10. Other Bonds
a. Income pay interest only if a company has profits
b. Collateral trust bonds backed by securities of other companies that
are owned by issuing firm
c. Equipment trust cert secured by movable equipment
d. Index interest rates tied to an economic index used most often
when a high level of inflation is present/possible
e. Economic development bonds typically issued by developing countries
for express purpose of fostering development of infrastructure & related
f. Tax increment financing TIF used primarily for local financing where
a muni may use all/portion of new property taxes within a district to
assist in projects financing
g. Tender option bonds allow holder to redeem bond either once in its
life or on specified dates usually at par value
h. Foreign bonds sold in a country by a foreign borrower - denominated
in domestic currency of issuing country
i. Multicurrency bonds usually issued as:
i. Currency option bonds allowing investors to choose among
several predetermined currencies
ii. Currency cocktail bonds denominated in a standard basket of
several currencies
iv. Other Forms of Debt Capital
1. Floating- (Adjustable-) Rate Debt
a. Interest payments reset periodically based on movement in a rep.
interest rate index such as LIbOR or US T-Bill
b. Stated as spread from basic index rate (e.g LIBOR + 3%)
c. Attractive to investors during periods of RISING interest rates
d. Borrowers prefer this because they can take advantage in DROP in
interest rates
2. Project Financing
a. Applies to large projects, often in energy also used for private
infrastructure
b. Lenders are paid from projects cash flows generally without recourse
to projects individual sponsors/owners
3. Securitization
a. Primary corporate applications accounts receivables and inventory
b. Increases liquidity and thus lowers cost of capital to borrowers
c.
4. Off-Balance Sheet Financing
a. Ex: joint ventures, R&D partnerships, sales of receivables factoring,
and operating leases
b. Often used by orgs with high debt levels or with very restrictive
covenants on use of additional debt
c. Operating leases = most common
v. Debt Contract Provisions
1. Debt (Bonds and Term loans) Indentures and Covenants
a. Indenture legal document outlining the rights and obligations of the
borrower and lender
b. Covenants may be negative or affirmative
i. Negative actions company CANNOT take
ii. Affirmative actions company MUST take
c. Covenants ma also include change-of-control and most-favored-
nation clauses that provide buyer/lender relief in certain cases
d. Purpose is to protect BH from actions by management that would
heighten risk to lenders or increase value for EH at their expense
2. Representations and Warranties (pg 154)
a. Existing conditions at time when loan agreement is executed
3. Events Default
a. May occur if borrower violates any condition under a debt agreement
b. Cure period time when an event by default may be corrected before
lender pursues default remedies
c. Remedies normally includes acceleration of all principal and interest
on debt when a default occurs
d. Waivers of default may be given a lenders discretion
4. Material Adverse Change Clause MAC
a. Lets a lender refuse funding or declare a borrower to be in default
even if all agreements are in full compliance if lender believes a
material adverse change has occurred in borrowers condition
b. Used to renegotiate terms and NOT to cancel usually
5. Call and Put Provisions
a. Give issuing entity right to call in the bond/issue prior to maturity (call)
b. A call premium is generally paid
c. Valuable b/c allows company to redeem issue if interest rates fall or
excess cash becomes available
d. Put allows holder to force issuer to repurchase debt at specified dates
i. Debt will be redeemed at par creates a floor price for debt
6. Sinking Funds
a. This provision requires companies to call/repurchase on the open
market a portion of the outstanding bond issues each ear
i. This essentially amortizes the bonds issue over its life
b. Other types requires a company to make payments into a trust account
amassing a lump sum for retirement of the bonds at maturity
i. Increases safety of bonds and lowers required rate
7. Refinancing
a. Often done following periods of high interest rates
8. Defeasance of Debt
a. Removes debt from balance sheet without retiring the issue
b. Borrower places sufficient funds in escrow (usually gov securities) to
pay for interest and principal
c. Since control of debt and escrow funds is relinquished, it can be
removed from balance sheet
9. Promissory Note
a. The legal portion of debt contract
b. An unconditional promise to pay a specified amount plus interest at a
defined rate either on demand or on a certain date
c. Master note used to simplify the paperwork connected with loans with
multiple advanced features such as lines of credit and revolvers
10. Collateral
a. Asset used as security for loan or bond issue
11. Liens
a. Legal claim on assets used as collateral
b. Other Factors in Using Debt as a Source of Capital
i. Credit Enhancements
1. Used to improve overall credit rating reassurance borrower will honor
obligation
2. Can be in form of L/C or backup line of credit
ii. Guarantees
1. Full guarantee party full guarantees any borrowing
2. Specific-project guarantees only loans relating to specific projects
3. Guarantee of payment or collection guarantee party agrees to make payment
on loan or collect payment from subsdiary, only if it formally defaults
4. Comfort letter not legally enforceable letter from another party stating
actions it will or will not take on behalf of the borrower
5. Performance
6. personal
iii. Bond/Credit Ratings
1. Reflects default probability
2. Considerations
a. Rating criteria qualitative and quantitative
b. Importance of ratings to investors and management
c. Changes in ratings
iv. Maturity Matching
1. Matches the life of a debt issue to life of any assets being financed
2. Primary risk maturity mismatched with longer-term assets funded with short-
term sources
a. Short term debt must be rolled over = exposure to changing interest
rates
v. Effects of Interest Rate Levels and Forecasts
1. Impacts use and cost of debt
2. Flight to Quality preference of safe or quality investments in declining
market conditions. Yield spread between high and low risk investments
increases
vi. Availability of Collateral
1. Companies with large asset bases that can be used as collateral typically
borrower at lower rates






































Chapter 11 Short-Term Investing and Borrowing


I. Pricing and Yields on Short-term investments (III.)
a. Factors influencing Investment Pricing
i. Yield Curve
1. Plot of yields of various maturities on the same investment class
2. Normal yield curve short term rates are often lower than longer term rates
3. Liquidity preference theory investors demand a yield premium in compensation
for lower liquidity associated with longer maturity
4. Inverted yield curve - investors shift preference for long-term securities or
borrowers shift preference to short-term borrowing
a. This demand increases prices = lower interest rate (investors)
b. This demand increases interest rates (borrowers)
5. Inverted curve = sign of recession in near future low inflation expectations
ii. Tax Status
1. Affects yield exempt securities provide lower yield
2.



b. Yield Calculations for Short-term Investments
i. Yield Calculation Principles and Examples
1. Yield of any short-term investment is function of:
a. Cash flows received from investment
b. Amount paid for investment
c. Maturity or holding period
2. Year basis number of days in year
a. Money market yield = 360-day year
b. Bond equivalent yield = 365-day year
3. Yield Calculations
a.



b.



4. Discounting Calculations (T-bills, CP, and BAs = money market)
a.
b.

c.

ii. T-Bill Quotes and Yield Calculations
1. Ask quote discount at which DEALER will SELL T-bill (360-day year)
2. Bid Quote discount at which DEALER will BUY T-bill (360-day year)
3. Ask yield yield to an INVESTOR purchasing T-bill @ ask discount (365-day
year)
4. Use equations in above section

II. Managing short-term financing (IV.)
a. Introduction
i. Maturity of less than 1 year
ii. Used to finance CAs such as A/R and Inventory
b. Short-Term Funding Alternatives
i. Trade Credit
1. Primary source of short-term financing used by many businesses
2. Buyer receives goods but payment isnt made until a later date
ii. Internal Borrowing
1. Best source of low-cost funds
2. Multiple units of an organization separate subsidiaries may borrow and lend
amongst themselves intra-company lending
3. Affected by many laws and regulation
a. Length of time that intra-company loans are outstanding affect whether
payment of principal is treated as return of capital or return of
dividend for tax purposes
iii. Selling of Receivables
1. Receivables may be factored sale/transfer of title to a factor third party
2. Securitization is another method to sell A/R
a. Company issues debt securities backed by a pool of A/R
b. A/R suitable for securitization have predictable CFs (adequate to retire
the issue) and historical record of LOW losses
iv. Commercial Bank Credit
1. Chief source of working capital for most companies
a. Offered on a secured or unsecured basis
b. Security provided by collateral or guarantees used to obtain favorable
rates
2. Loan Syndications and Participations (pg 341)
a. In L.Ss, multiple FIs share the funding of a single credit facilitate
b. The syndicate or group of lenders is led by an agent/intermediary to
negotiate credit terms and documentation, make advances and collect
payments on the loan, and disseminate info
c. In a Participation a FI purchases an interest in another lenders credit
facility
i. Purchaser = participant
ii. Seller = lead institution
d. Purpose of these arrangements is to allow banks to offer larger loans
then they could on their own: due to capital requirements
3. Lines of Credit
a. Overview
i. Lender gives borrower access to funds up to a max amount
over a period of time
b. Covenants and Conditions
i. Cleanup requires a period f 30 60 consecutive days with no
outstanding borrowing (ensures that it is used for short-term)
ii. Covenants focus on maintaining certain liquidity or coverage
ratios, or max debt ratios
iii. MAC clause
iv. Good internal reporting and cash forecasting are essential
c. Types of Lines
i. Secured borrower must pledge collateral
ii. Uncommitted line lender offers to make funds available in
the future without obligation as to a specific amount
1. A.k.a discretionary line of credit
iii. Committed line formal loan agreement with terms and
conditions
iv. Guidance line/operating risk exposure limit
1. Used to accommodate credit exposure created from
operating activities (Ach operations, returned
deposits, FX exposure, etc.)
d. Compensating Balances (pg 342)
i. Balances maintained in companys deposit accounts at the
bank for purpose of increasing overall revenue of bank on acct
e. Pricing
i. Cost components:
1. All-in rate of interest
2. Commitment fees, can be on used/unused balances
3. Compensating balances
ii. All-in rate consists of base rate (LIBOR, US prime, Fed funds
rate) plus or minus a spread
iii. Total interest paid = all-in rate * loan balance outstanding
f. Revolving Credit Agreements
i. Revolving credits formal, contractual commitments with loan
agreements & covenants
ii. Usually a commitment fee on unused portion along with fee for
use of borrowing
iii. Usually used for short-term but commitment term ranges from
2 to 5 years
iv. Contain all characteristics of committed lines
v. Additionally, feature short-term, fixed-rate funding options that
offer fixed-rate loans for specified period with penalties
imposed for prepayment
v. Single Payment Notes
1. Granted for short period and with purpose
2. Both interest and principal paid at maturity
vi. REPOS
1. Let companies tap into liquidity of their investment portfolio without disposing of
their investments in money market instruments d
2. Equivalent transaction = single payment note secured by marketable securities
vii. CP issuance
1. 3(a)(3) program
a. Issuer can issue up to 270 days in minimum amounts of $100,000
b. Proceeds may only be used for working capital purposes
2. 4(2) program
a. Can issue up to 397 days in minimum amounts of $250,000
b. No restriction on how proceeds are used
3. Specifics
a. Sold at discount
b. Discount rate is calculated on 360-day year
c. Costs include dealer fees, backup credit facility fee, rating agency
charges, and any credit enhancement costs
4. Desirable
a. Only when ongoing funding needs are large because of the effort and
high fixed costs
viii. Asset-Based Borrowing
1. Typically secured by A/R or inventory supports temp financing needs
c. Pricing and Costs of Principal Short-Term Financing Sources
i. Annual Cost for CP Issuance
1. Total costs to issue CP: interest rate implied in discount, dealer fee, fee for credit
enhancement
2.

3.

4.

5.

ii. Annual Cost for A Line of Credit
1. Interest and a commitment fee on an annual basis
2. Overall interest rate: total interest paid on lines used portion and amount paid
for commitment fee relative to the average used portion of line over borrowing
period
a.



b.
c.
3. Compensating Balance effects
a.



b. Amount that must be borrowed on the line to have a certain $ amount
when considering compensating balances
i.


ii. the larger amount borrowed increases the total interest and
fees paid (interest paid and unused portion fee equations)

III. Debt Financing (V.)
a. Costs of Borrowing
i. Primary cost = interest
ii. Other costs = credit enhancements, credit agencies, legal fees, commitment and facility
fees, broker fees, dealers/investment banks for underwriting, registration and regulatory
fees
iii. Indirect costs = costs of negotiating and maintaining covenants
b. Basic Components of Interest Rates
i. ; where
1. IP = inflation prem, DP = Default prem, LP = liquidity prem, MP = maturity prem
ii. Combo of real risk-free rate & short-term rate of inflation usually = rate on T-Bill
c. Base Rates
i. Usually includes adjustments for inflation and maturity premiums
ii. Spread will factor in adjustments for default and liquidity premiums
iii. Influenced by economic conditions and yield curves
iv. Fed funds rate = interest US banks charge to borrow reserve balances from each other
v. Prime rate usually 3 percentage points above fed funds rate
d. Short-Term versus Long-Term Borrowing
i. Historically, short-term < long-term rates (normal yield curve)
ii. Short-term borrowing carries 2 risks not seen in long-term borrowing
1. Fluctuation in market interest rates
2. Availability of funds
iii. Long-term borrowing on a fixed-rate basis stabilizes interest costs provides a narrow
range for fluctuation in interest costs on a variable rate, long term loan with interest rate
collar
iv. Operational Advantages of short-term financing
1. Ease of access
2. Flexibility
3. Ability to finance credit needs efficiently
4. Less restrictive covenants
v. Operational Disadvantages of Short-term Financing
1. Continuing need to renegotiate or ROLL OVER the financing
a. Lender may not agree because of changing financial variables
2. Asset based lending one approach of continued short-term debt that carries
lower risk
3. Downsides of secured lending:
a. Assets used as security must be monitored
b. Key ratios related to assets must be maintained
c. Lending is limited to some percentage of asset values
e. Loan Agreements and Covenants
i. For bonds covenants typically determined from negotiations with the rating agency as
part of the rating process
ii. Some restrictions from covenants:
1. Ability to sell certain assets
2. Right of an organization to issue bonds
3. Use of second or junior mortgages
4. Key ratios that limit flexibility in financial decision making
5. Payment of dividends
f. Credit Rating Agencies (CRAs)
i. Classes of Ratings
1. issuer credit ratings
a. an opinion on the obligors (issuers) overall capacity to meet financial
obligations includes counterparty, corporate credit, & sovereign credit
ratings
2. issue-specific credit ratings
a. consider the attributes of the issuer, as well as specific terms of the
issue, quality of the collateral, and creditworthiness of the guarantors
ii. The Rating Process
1. Quantitative Analysis
a. Financial analysis
b. Based on financial reports
2. Qualitative Analysis
a. Quality of management
b. Analyze firms competitiveness within its industry
c. Expected growth of the industry
d. Vulnerability of industry to business cycles, tech change, regulatory
changes and labor relations
3. Government issue rating
a. Based on analysis of the economy, debt levels, finances (tax rev and
expenses), financial statements and administration strategies
b. Other factors are primary source of repayment from general taxes or
specific revenues and collateral for the debt
iii. Review of Ratings
1. Reviewed once a year by rating agencies
2. Review based on financial reports, new business info, or review meetings with
management
iv. Credit Rating Scales
1. Page 358 chart


















































Chapter 12 Long-Term Capital Investments


I. Managing Capital Market Investments
a. Objectives of Capital Market Investments
i. Issues to Consider:
1. Risk preferences
2. Return objectives
3. Liquidity needs
4. Time horizons or future needs for funds
5. Tax issues
6. Legal or regulatory factors (esp for pension fund inv)
ii. Analysis of Risk Tolerance
1. Once risk tolerance is determined type of return required by investor must be
considered
2. Return objective may be stated in terms of:
a. An absolute return annualized return of 12.5%
b. A relative return exceeds return on 10-year Treasuries
c. A general goal current income, total return, etc
iii. Capital Preservation
1. Want to maintain purchasing power of investments while minimizing risk to loss
2. Suitable short-term MANAGEMENT strategy, but may not be suitable for capital
investments
a. Assumption that the company can ride out short term downturns that
would detriment a short-term portfolio
iv. Return Objective
1. Some mix between current income and capital appreciation
2. May be impacted by the intended use of those returns (think pension fund)
b. The Asset Allocation Decision
i. Capital investment mix
1. Fixed-income securities provide their returns in the form of a relatively
predictable stream of income
2. Equities have a higher potential for long-term gain and higher risk of loss
3. Equity investments provide returns as a mix if both income and capital
appreciation/depreciation
ii. Structure of portfolio
1. Objectives
a. The longer the desired maturity the greater risk tolerance greater
use of equity
2. Consider taxes (capital gains and income)
c. Long-Term Fixed-Income Debt Portfolio Management
i. Duration** (pg 368)
1. gives estimate of volatility of investment
a. longer duration = more price volatility = sensitive to interest rates and
vice versa
2. Duration measures # of years to recover true cost of a bond
3. (


) (


) (


)
4. Factors affecting bond duration:
a. Time to maturity longer maturity = longer duration
b. Coupon rate higher coupon = lower duration
ii. Interest Rate Risk
1. Longer duration = more interest rate risk **(page 370 chart)
iii. Diversification
1. Reduces overall risk
iv. Fixed-Debt to Floating-Debt Ratio
1. Ratio corresponds with firms views on long-term interest rates
a. Increase in LT rates = lower FD/FLD because theyd most likely invest
in more floating-rate investments
2. Use float-rate investments when they believe they have means to support
additional interest rate exposure
3. Disadvantage of managing portfolio solely on this ratio
a. Fail to consider maturities of securities
v. Foreign-Currency-Denominated Investments
1. FX risk must now be considered in addition to default and interest risk
vi. Using Derivatives in Long-Term Fixed Income Portfolio
1. To manage interest rate risk use swaps, futures, and options
2. Credit risk credit default swaps
a. CDS seller of CDS will pay buyer in event of loan default or other
credit event (bankruptcy) on the part of a particular issuer.
3. Currency risk FX futures, forwards, options, an d swaps
vii. Asset/Liability Management
1. This issue comes up when an investment portfolio uses borrowed funds as part
of its overall strategy
2. Mostly issue is expressed in terms of maturity mismatch
3. Using ST funding for LT assets is only profitable if yield curve is upward sloping
viii. Securities Lending
1. The owner of specific securities lends them to another party with collateral for a
negotiated fee
2. Primary purpose is to allow borrower to hedge or short-sell (anticipate drop in
value)
3. Also used to cover failed transactions when seller of securities is unable to
deliver them on settlement date
d. Equity Stock Portfolio Management
i. Defining and measuring Investment Risk
1. Risk possibility of discrepancy between ACTUAL results and EXPECTED results
with an estimation of the difference
a. Use stdev to estimate individual asset variances
b. Use covariance to estimate how 2 or more assets change relative to one
another
ii. Diversification
iii. Capital Asset Pricing Model CAPM
1.
iv. Determining Portfolio Risk and Return



Chapter 15 Operational and Enterprise Risk Management


I. Enterprise Risk Management ERM (III)
a. Market Risk** (chart page 445)
i. Equity price risk
ii. Interest Rate Risk
iii. FX Risk
iv. Commodity Price Risk
b. Credit Risk
i. How change/downgrade in credit quality affects value of a security
c. Operational Risk
i. Potential losses stemming from inadequate systems, management failure, faulty control,
fraud and human error
d. Liquidity Risk
i. Funding liquidity risk
1. Ability to raise necessary cash to meet its obligations as they come due
2. Linked to ability to raise capital (ST and LT)
ii. Asset liquidity risk
1. Ability to sell an asset quickly AT or close to its true value
e. Legal and regulatory Compliance Risk
f. Event Risk
i. Risk associated with unexpected events unplanned corporate reorganization or natural
disaster
g. Business Risk
i. Classic risks in operating a business uncertainty of demand for products/services, cost of
producing
ii. Associated with day-to-day management of a company
h. Strategic Risk
i. Risk of major investments for which there is a significant uncertainty about success
i. Reputation Risk
i. Risk that customers, suppliers, investors, regulators, etc. may decide that a company has
a bad reputation and decide not to do business with it
II. Operational Risk Management (IV)
a. Internal Operational Risks
i. Employee risk
1. Defalcation risk risk of intentional employee fraud
a. Fidelity risk the specific case of theft of money, securities or
property
2. **Also includes purposeful violation of policies to improve performance ratings,
compensation, or as cover-up
3. Most internal risk can be addressed by - strong internal controls
a. Segregation of duties
b. Maker-checker controls
c. Periodic self-audits
d. Management oversight
e. insurance
ii. Process Risk
1. Lack of proper controls or failure of employees to follow procedures
2. Financial reporting errors
3. Lack of timely reconciliation of bank accounts
4. Highly complex processes people dont understand them, how to use them or
their limitations
5. When an organization may not be able to meet terms of contracts with
customers and suppliers
6. Errors in clearing and settlement for financial transactions
iii. Technology Risk
1. Security breaches (external) or security violations (internal)
2. Choosing a tech platform over another obsolescence, failure of system and
support with risk that vendor may go out of business
3. Difficulty to monitor, and audit complex spreadsheet models
b. External Operational Risks
i. Financial Institution Risks
1. Potential failure of your FI and the impact on your company loss of balances,
diminished borrowing capacity, disrupted services)
2. Operational failures by FI performing daily transactions processing
3. Communication failures between FI and company
ii. Counter-Party Risk
1. Risk that the other party in a contract or financial transaction will not perform
iii. Legal and Regulatory Compliance Risk
1. Potential lawsuits or other legal actions instigated by customers, trade partners,
or gov agencies and regulators
2. Sovereign risk risk of interference of foreign gov in settlement of a foreign
transaction
3. Political risk economic impact faced by businesses due to political
change/decisions
iv. Supplier Risk
1. A specific type of counter-party risk
v. External Theft/Fraud Risk
1. Primary source payment process
2. Reduce by replacing paper-based payments with electronic
vi. Physical and Electronic Security Risk
vii. Natural Disasters Risk
viii. Terrorism Risk
c. Fundamental Factors for Operational Risk Management Strategy
i. Importance of Organizational Culture
1. Employees observing improper behavior by management or actions not in
shareholders best interest must be able to report these activities without being
penalized
2. Best approach culture promoting individual responsibility and is supportive of
educated risk taking
ii. Importance of Technology
1. Critical in formation of strategies related to operational management
2. Necessary to help gather, analyze, and then monitor operational controls and
procedures
3. Reduces manual errors and limits access by non-authorized personnel
iii. Importance of Guidelines for Board of Directors (page 453)
1. Important in reducing overall operating risk





Chapter 17 Treasury Policies and Procedures


I. Policy Development Example: Short-Term Investment Policy (IV)
a. The Importance of Having and Investment Policy
i. Establishes a clear understanding of firms investment philosophy and OBJECTIVES
ii. Can set clear parameters for its investments
1. Better manage liquidity, monitor compliance, minimize risk
iii. Becomes more crucial in decentralized and geographically widespread companies
b. Setting Investment Objectives
i. Safety
1. Credit quality indicates probability of default measures safety of the principal
2. Investment research used to evaluate credit risk
3. Volatility important measure of both liquidity and safety
a. Related to maturity in bond investments (long maturity = high volatility
b. Related to stocks, beta is used
ii. Liquidity
1. Seasonality may help define a firms liquidity needs
2. Not primary obligation in long-term portfolios where maturity can be matched
closely with need for funds
iii. Risk/Return Trade-Off
1. Risk tolerance is key determinant
c. Developing a List of Permitted Investments
i. Comes after establishing investment objectives
ii. Sometimes based on minimum credit ratings (CP w/ min rating of A-1/P-1)
iii. Global companies approved list may further specify acceptable issuer countries, and in
some cases, specific industries within countries
d. Investment Requirements
i. Diversification approaches
1. Allocating investments by asset class
2. Hold a % of foreign securities minimize impact of movement in currency
3. Limit investments from specific issuers and/or instruments limits concentration
risk
ii. Investment or Exposure Horizon
1. Investment horizon time firm expects or is willing to hold an investment
2. Exposure horizon function of firms risk philosophy and total interest rate
exposure already present in other areas of the organization
iii. Other Limitations on Investments
1. Clearly state firms attitude toward maintaining simultaneous debt and
investment positions
2. Specify any limits on holding of less-than-liquid assets
3. List financing and/or credit requirements for FIs and other companies in which
investments are made
4. Define credit requirements and guidelines if foreign investments are allowed
5. Ensure that collateralization and guarantee guidelines are specified clearly
e. Other Issues in Developing an Investment Policy IP (page 517)
i. Valuation of Investments **
1. IP should state process used for investment valuation and management of
impaired investments
ii. Exception Management
1. Include provisions to accommodate exceptions ex. Investment opportunities
that fall outside of the approved list -> procedure for obtaining exception
approval
2. Should include guidelines how to handle downgraded investments falling below
policy guidelines
3. Identify individual or group whose approval is required for exceptions
4. Detail actions and procedures deal with exceptions found during compliance
testing
iii. Use of External Money Managers**
1. Should be subject to provisions of the corporate investment policy
2. Clearly describe their roles and responsibilities critical if theyre involved in the
investment process
iv. Performance Measurement and Reporting
1. Performance Measurement
a. Evaluate against established benchmarks
b. Benchmarks consistent with company goals and based on permitted
investments
2. Reporting
a. Designed to accomplish specific goals with different levels
b. Any breaches of investment limits and how they were remedied should
be reported
c. Weekly/monthly performance reports
d. Contain explanations of any fluctuations in average rates or investment
balances include projections for next period
3. Calculating Returns
a. Most popular methods: total return, current yield, and YTM
b. When comparing returns essential that they are all calculated the
same way
v. Policy Compliance
1. Need for regular policy compliance review and evaluation identify parties
responsible for this
vi. Internal and External Controls
1. Custodial Service Providers
2. Limitation of Liability
vii. External Restrictions



















































Chapter 20 Financial Decisions and Management

I. Cost of Capital and Firm Value (IV)
a. Capital Components and Costs
i. Source of permanent capital long-term debt (bonds) and equity capital (common stock
and retained earnings)
1. Their relevant cost their marginal cost rate of return demanded by market if
funds were raised today
2. Use after-tax costs
b. Cost of Debt
i. Relevant cost of debt = after-tax cost
ii. For a bond pre-tax rate of cost = YTM
1. YTM rate of return earned over a bonds remaining life based on its market
price at the date the measure is taken
c. Cost of Common Equity
i. Funds raised through RE, and/or issue new common stock
ii. Markets required rate of return applies to RE and common stock
iii. If the board chooses to reinvest all/some of earnings in the business, SH expected a rate
of return on this investment
iv. CAPM used to estimated markets required rate of return (RROR)
1. R
e
= r
rf
+ (r
m
r
rf
)
d. WACC
i. Determines a companys cost of capital
e. Firm Value
i. EVA discussion firm must earn ROR on assets > cost of capital in order to create SH
value
1. Return on assets > WACC to create value
2.



ii. EVA = EBIT(1 Tax rate) (WACC)(Long-term Debt + Equity)

II. Lease Financing and Management (V)
a. Introduction
i. Acquisition process by which a company acquires a particular building or asset basing
decision on regular capital budgeting procedures
ii. Financing asset must be financed through borrowing or leasing leasing has same
effect on capital structure as borrowing
1. CF from leasing are compared to CF from borrowing funds
b. Why Companies Lease
i. Key reason tax benefit for both lessor and lessee
1. Can be used as off-balance-sheet financing
ii. LT leasing direct substitute for debt in capital structure esp if you have poor credit
iii. Appealing if assets have high potential for tech obsolescence (computers)
iv. Appealing to start-ups or if you are beginning sales in a new area high level of
uncertainty about future demand
1. cancellation provisions of lease = protection
v. may choose to lease assets for operations outside of usual expertise
c. Types of Leases** (chart on page 618)
i. Differences among lease types:
1. Length
2. Party responsible for maintenance and upkeep
3. Value of asset at end of lease
4. Relevant tax treatment
5. Who retains asset at end of lease and under what terms
ii. Sale-and-Leaseback Arrangements
1. Asset owned by company is sold to another party (lessor) asset is immediately
leased back to its original owner (lessee)
2. Aids companies that need a cash infusion
3. Used by companies that cannot take full advantage of tax benefits from
depreciation excessive operating losses
iii. Operating or Service Leases
1. Lessor may maintain asset and retain ownership at end of lease
2. Often done on an off-balance-sheet basis lease payments only show up on
income statement as an expense
3. Usually run for periods shorter than life of equipment
4. There is residual value of the asset at end of lease term
iv. Capital or Financial Leases
1. Essentially an alternative to borrowing funds and purchasing the asset
2. 4 conditions:
a. Length of lease at least 75% of useful life of asset
b. Transfer of ownership to lessee at end of term
c. Bargain purchase option during or at end of leases life
i. Bargain price sufficiently less than fair market value
d. PV of discounted lease payments at beginning of lease > 90% of assets
fair market value
3. An operating lease = a lease that meets none of these conditions
4. Double-net lease lessor receives payment after expenses are paid
a. Expenses maintenance, operating & insurance
b. Triple-net lease in real estate further includes taxes, insurance, and
utilities
d. Estimated Residual Value
i. Assets with potentially high residual value have lower lease payments
e. Tax Considerations for Leases
i. In US full amount of annual operating lease payment = tax-deductable expense
1. Provided IRS agrees that the contract is genuinely an operating lease
2. Reason for IRS restrictions prevent a more rapid write-off of assets than is
allowed by IRSs depreciation rules
ii. Lease classification: Capital or Operating Lease
1. Depends on whether lease transfers risks and rewards of ownership to the lessee
iii. Most tax legislation aims to prevent deductions for interest expense when tax avoidance
is a main reason for undertaking the lease
f. Lease vs. Borrow-and-Buy Decision
i. Compare costs of leasing vs. costs of borrowing to buy the asset
1. Examine NPV of CFs
ii. Calculated example: lease vs. borrow and buy (page 621-622)

III. Equity Financing and Management (VI)
a. IPOs and Decision to List Stock in US
i. IPO
ii. Advantages of Going Public
1. For investors provides liquidity
2. Allows value to be determined by market establishes companys stock price
iii. Disadvantages of Going Public
1. Regulatory disclosure
a. Competitors gain access to greater amount of info
b. Compensation/net worth of owners is determined more easily by
outside parties
c. Financial reporting attestation & internal control requirements
d. Registration and disclosure are expensive for an IPO
2. Managerial flexibility
a. Less flexibility for managers
b. Conflict between SHs and management (with regard to salaries and
perks)
3. Control
a. Owners/managers surrender some control when going public even if
majority ownership is maintained
b. Minorities get better representation/control with cumulative voting
4. Other factors
a. If there is small market for the stock/company market price may not
reflect true value
b. Going public with debt securities = need to get it rated to sell publicly
i. Expensive as shit
iv. Decision to List Stock
1. Advantages
a. Stock marketability increases traded more widely and more invetors
can access it
b. Increased public exposure higher sales
c. Reduces perceived market risk may lower WACC, thereby increasing
overall market value
2. Disadvantages
a. Reporting and governance requirements can go well beyond
government regulation
b. Higher costs charged by exchanges
v. Delisting of Stock
1. Involuntary delisting company has fallen out of compliance with exchange
requirements
2. Voluntary delisting
a. Added disclosure requirements and expenses of auditing and reporting
have caused many smaller companies to delist
vi. Choice of Exchanges
1. If you wish to raise capital globally list on worlds money centers
a. NY, Toronto, Tokyo, Frankfurt, Paris, HK, etc
2. US companies may be listed and traded on exchanges outside US
a. Same for foreign companies in US
vii. Type of Stock (to issue)
1. Dual-class
a. 2 types of stock issued: Class A and Class B stock
b. One class is sold to the general public has limited voting rights but
with preferential dividends
c. Second class is reserved for original owners and executives greater
voting power to maintain majority control
b. Shareholder Rights
i. Control of company
1. Have right to elect a companys directors who in turn select officers to manage
the business
ii. Cumulative voting
iii. Proxy
1. Right to vote can be assigned to another individual through a proxy
iv. Staggered election of directors
v. Preemptive right
1. Existing SHs shall have the first right to purchase shares of any NEW stock issue
on a pro rata basis and based on proportion of shares owned
c. Mergers and Acquisitions
i. Types of transactions
1. Merging 2 companies
a. 2 firms about the same size merge to form a single new company
2. Acquisition of a company
a. One company buys a majority of voting shares of another
b. Good takeover candidate cash rich business, low D/E, significant
growth potential
c. Friendly acquisition extensive due diligence into financials of target
3. Hostile takeover
a. Acquiring firm will make tender offer directly to SHs, bypassing
management
b. Acquiring firm may only know publicly available info greater risk
because of limited due diligence
c. Tender offer represents cash offer for common shares held by
stockholders
i. Generally more expensive than negotiated M&As due to
resistance of target management
d. Second approach engage in proxy fight prior to targets annual SHs
meeting
e. A third approach creeping tender offer quietly purchasing sufficient
stock in the open market to enable a change in management
4. LBO
a. When an entity finances the acquisition of company primarily through
borrowing typically collateralized by assets of company being acquired
b. Debt carried on balance sheet of acquired company
c. Repayments made from operating CFs of acquired company
d. Can also be used if a firm wants to go private
e. Most cases SHs of target firm receive more than current price of
stock
f. More risk than an acquisition paid for through issuance of equity
i. High level of debt and need to generate on-going CFs to make
payments
ii. Financing the Transaction
1. Common structures
a. All cash transaction
b. Stock transaction
c. Mixed stock/cash transaction
d. Leveraged cash transaction, financed through debt issue
e. Debt transaction
f. Mixed cash/debt transaction
g. Preferred stock transaction
2. cash sources to pay for acquired firm
a. cash from acquiring firm
b. excess cash from target
c. cash from sale of targets assets
d. issuance of investment-grade bonds
e. issuance of below investment grade bonds with amortization schedule
supported by a forecast of operating CFs
d. At the Market ATM Programs
i. An alternative to traditional underwritten offering of a fixed # of shares at a fixed price all
at once
ii. ATM allow for issuance of a specific amount of equity over time sold into existing
secondary market at current market price on an AS-NEEDED BASIS
iii. Dribble plans called this because stock is issued in small increments as to avoid
impacting the market price